Front end interest rate volatility remained elevated this week, with the market adding an additional 25bps increase in Fed funds post the record CPI print – January 2023 Fed Fund futures traded at a 3.49% rate a week ago, touched a 3.74% Thursday morning only to settle back to 3.50% by Friday afternoon. The shockingly high CPI print has been tempered by softer data. Headline retail sales point to a consumer muddling along – combatting higher energy prices by buying less elsewhere. The exceptions are restaurants, a slight bounce in vehicles and strength in online shopping. Overall real retail sales have fallen two months in a row. University of Michigan surveys released Friday showed a slight uptick in sentiment following June’s abysmal readings and also a slight downtick in longer term inflation expectations. The relief rally – data dispels fears of 100bps rate rise – leaves stocks up 1.7% on the day and off just 1% for the week.

As if the investing environment couldn’t be more challenging, this week only served to further muddy the water. Fed Chairman Powell testified before Congress in what was once referred to as the Humphrey-Hawkins testimony. The testimony is mandated twice a year and the Chairman is tasked with justifying his dual mandate of keeping unemployment and inflation low. His testimony was mostly comments Congressmen don’t want to hear. Namely, acknowledging that rising interest rates poses the risk of a recession, and that the employment market is running “too hot.” In the perverse thinking of bond investors that was good news. The logic goes that If the Fed Chairman is thinking that the coming rate hikes could result in a recession, then that means that inflation will be coming down faster than they had hoped and, therefore, rates will need to be cut sooner than anticipated. Taking their cue from bond investors, the stock jockeys interpreted that logic as a signal to buy, hence the 6% rise in the S&P 500 off the low touched last week. Notably, Powell didn’t say anything at the testimony that would indicate that the committee has changed their mind about raising rates another 75 basis points at the end of July.

President Biden and the members of the Federal Reserve were hoping against hope that this morning’s CPI report would come in below expectations, but to no avail. In fact, each and every one of the economic releases communicated bad news to our leaders. The headline year-over-year CPI came in at 8.6% versus the consensus estimate of 8.3%, and the ex-food and energy tally came in at 6.0%, a touch above the survey estimate of 5.9%. Later in the morning the University of Michigan consumer survey offered no better news. The overall sentiment tally plunged to 50 versus last month 58, and the inflation component for the coming year ticked up to 5.4%. That’s a clear message to Messrs. Biden and Powell of no confidence. The reaction out of the markets was as expected with Stock indices getting crushed. Several intrepid market analysts said earlier this week that the stock market could be close to a bottom, but they’re eating their words today as the S&P 500 is only 100 points away from its recent low.

Bond prices continued to rebound this week with the front end out performing. The yield to maturity on the 2 year US Treasury Note declined another 10bps to 2.49% while the yield on the 30 year Bond remained the same at 2.99%. The steepening of the yield curve is the result of participant’s expectation of slower growth and lower inflation going forward. The chart below shows that participants removed future expected rate hikes over the course of the next year – effectively recalibrating the terminal fed funds rate lower. The mid-month equity swoon and the string of earnings misses added to the bullish sentiment in the front end.